TWR vs IRR: Which Return Metric Actually Matters?
TL;DR
- ▸TWR removes cash flow timing — the standard for evaluating investment strategy and comparing to benchmarks.
- ▸IRR (money-weighted return) reflects your personal return including the timing of your deposits and withdrawals.
- ▸XIRR is the practical implementation of IRR for irregular cash flows; Modified Dietz approximates TWR efficiently.
- ▸They diverge most when large deposits or withdrawals happen near market extremes.
- ▸DonkyCapital calculates both automatically and displays them at portfolio and individual asset level.
If you've ever wondered why your portfolio shows different return numbers depending on which metric you look at, you're not alone. TWR (Time-Weighted Return) and IRR (Internal Rate of Return) measure portfolio performance differently — and each tells a different story. The gap between them can be significant: a portfolio with heavy cash flows can show a TWR of +12% and an IRR of just +4% in the same period. Understanding why this happens is essential for any serious investor.
This guide explains the difference between TWR and IRR, when to use each, what the Modified Dietz method is, how XIRR compares to IRR, and how DonkyCapital calculates both automatically for your complete transaction history.
1. What is TWR (Time-Weighted Return)?
TWR measures the compound growth rate of an investment, completely eliminating the impact of external cash flows — deposits and withdrawals. It answers: "How well did my portfolio strategy perform, independent of when I added or withdrew money?" TWR is the industry-standard metric used by fund managers and regulated by performance reporting standards (GIPS) for exactly this reason: it isolates the manager's investment skill from investor timing decisions. Here's a concrete example: imagine two investors with identical portfolios and identical strategies. Investor A deposited €100,000 at market peak, watched it drop 20%, then recover to +10% net. Investor B deposited €50,000 at peak and €50,000 at the trough. Their TWR will be identical — same strategy, same portfolio — but their IRR will differ dramatically based on when they each invested. This is the core power of TWR: it's the only fair way to evaluate strategy quality. For individual investors, TWR answers 'is my investment approach actually any good?' — stripped of the noise created by your own deposit timing.
2. What is IRR (Internal Rate of Return)?
IRR — also called money-weighted return — measures the actual return you personally experienced on your invested capital, taking into account the precise timing and size of every deposit and withdrawal. It answers: "What was the real compound return on the actual money I put in and when I put it in?" IRR is highly sensitive to cash flow timing. A large deposit made just before a market crash will significantly lower your IRR, even if your investment strategy performed perfectly. Conversely, depositing money right before a strong rally will boost your IRR well above your TWR. XIRR is the spreadsheet-based implementation of IRR for irregular cash flows — it's what Excel and most portfolio tools actually calculate when they say 'IRR'. The terms are often used interchangeably in retail investing contexts. For individual investors, IRR answers the most personal question: 'how much money am I actually making on the capital I've put to work?' It's the number that reflects your real financial outcome, including the consequences of your own savings behavior.
3. When to Use TWR vs IRR — and Why Both Matter
The choice between TWR and IRR depends on what question you're trying to answer. Use TWR when you want to evaluate your investment strategy in isolation — it's the right metric for comparing your portfolio to a benchmark index like MSCI World or S&P 500. It's also the correct metric when asking whether you should stick with your current strategy versus switching to a passive index fund. Use IRR when you want to know the actual financial impact of your investing journey — it reflects the real-world consequence of your savings rate, deposit timing, and withdrawal decisions. Neither metric is superior — they're complementary. The most dangerous mistake is comparing your IRR to a benchmark's TWR and concluding you're underperforming. These are measuring different things. A sophisticated investor looks at both: TWR to judge strategy quality, IRR to judge personal outcomes. DonkyCapital displays both metrics simultaneously so you can always understand both perspectives without confusion.
4. Why TWR and IRR Often Diverge — Real Examples
The two metrics diverge whenever you make deposits or withdrawals at market highs or lows. Scenario 1 — Large deposit before a crash: You invest €200,000 in January. Markets drop 30% by March. You add another €50,000 at the bottom. Markets recover fully by December. Your TWR might show +5% (the strategy recovered), but your IRR will be much lower — perhaps -8% — because most of your capital experienced the full drawdown. Scenario 2 — Lucky DCA: You invest €1,000 per month throughout a year where markets fell 20% then recovered to flat. Your TWR is 0% (market went nowhere), but your IRR is positive — around +12% — because your monthly purchases bought more units at lower prices. Scenario 3 — Withdrawal at the bottom: You panic-sell 50% of your portfolio at the market low. TWR is unaffected (it ignores your behavior), but your IRR collapses because you crystallized losses on a large portion of your capital. This last scenario is the most instructive: TWR shows what the strategy could have done; IRR shows what your actual behavior produced.
5. How DonkyCapital Calculates Both — Modified Dietz and XIRR
DonkyCapital automatically calculates both TWR and IRR from your complete transaction history, using the most accurate methods available for retail investors. For TWR, DonkyCapital uses the Modified Dietz method for sub-period returns. This is an industry-accepted approximation that weights each cash flow by the fraction of the period it was invested, without requiring daily portfolio valuations. The formula is: Return = (End Value − Start Value − Cash Flows) / (Start Value + Weighted Cash Flows). Sub-period returns are then geometrically linked to produce the full-period TWR. The Modified Dietz method is used by most professional portfolio analytics systems precisely because it balances accuracy with computational efficiency. For IRR, DonkyCapital uses the XIRR formula, which is specifically designed for irregular cash flows. Unlike standard IRR (which assumes equal time periods between cash flows), XIRR accepts a cash flow amount and an exact date for each transaction, producing the true annualized internal rate of return. Both metrics are calculated at the portfolio level and for each individual holding, and both update in real time as you add new transactions.
Frequently Asked Questions
Which metric should I show my financial advisor?
Show TWR when comparing your strategy to a benchmark or evaluating a fund manager — it removes the distortion of your deposit timing. Show IRR when discussing the actual return on your personal invested capital. Presenting both gives the most complete and honest picture of your financial situation.
Can TWR be higher than IRR?
Yes, and this is very common. It happens when you invested a large sum before a period of poor performance. The portfolio strategy (TWR) may have recovered well over the full period, but your personal IRR reflects the real loss caused by the timing of your large deposit. The bigger the deposit near a market peak, the larger the gap between TWR and IRR.
Can IRR be higher than TWR?
Yes — this happens when you consistently invest during market dips (effective dollar-cost averaging) or when you made a large deposit just before a strong rally. Your IRR benefits from the good timing of your cash flows even if the underlying strategy (TWR) was modest. This is one reason IRR can make you look like a better investor than you actually are.
What is the Modified Dietz method?
The Modified Dietz method is an industry-standard approximation for calculating Time-Weighted Return without requiring daily portfolio valuations. It weights each cash flow by the proportion of the measurement period it was invested. For example, a deposit made halfway through a quarter counts as 50% weighted. It's widely used in institutional portfolio analytics because it's accurate enough for most practical purposes while being computationally efficient.
Is XIRR the same as IRR?
They measure the same concept — the internal rate of return — but XIRR handles irregular cash flow timing, while standard IRR assumes equal periods between cash flows. In real investing, deposits happen on arbitrary dates, so XIRR is almost always the correct formula to use. DonkyCapital uses XIRR for all IRR calculations.
Why is my IRR much lower than my TWR?
This typically means you made a large deposit near a market high, before a significant drawdown. The strategy (TWR) eventually recovered, but the bulk of your capital experienced the full decline first. Your IRR reflects that personal timing. The remedy is not to change strategy but to understand that this gap is entirely normal and expected in volatile markets.
Can DonkyCapital show both TWR and IRR for a specific date range?
Yes. DonkyCapital lets you select any date range — 1 month, 3 months, YTD, 1 year, 3 years, or custom — and both metrics are calculated for that specific period. This is particularly useful for evaluating performance during specific market regimes, such as comparing how your strategy performed during the 2022 bear market versus the 2023 recovery.
Does DonkyCapital calculate TWR and IRR for each individual asset?
Yes. DonkyCapital calculates both TWR and IRR at the portfolio level and for each individual holding. This lets you identify which specific assets have the best strategy performance (TWR) and which have delivered the best personal returns given your actual buy timing (IRR). These can differ significantly for assets you bought at different prices over time.
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